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The directors divide: the importance of separation of personal from company interests

Directors have an obligation to act in the best interests of the company to which they are appointed. This obligation includes the proper use of company funds. The recent case of Weaver v Harburn [2014] WASCA 227 emphasises the importance of directors keeping company funds separate from personal transactions.

WHAT HAPPENED?

Mr Harburn was the director of Harburn Group Australia Pty (Harburn Group), a company which provided financial, share broking and mortgage broking services. The company had a sole shareholder, Harburn Investments Pty Ltd. In 2007 Mr Harburn decided to reduce his workload and Harburn Group sold its financial services business client list, with the sale settling on or about 12 June 2007.

In July 2007 Mr Harburn decided to purchase a boat for his wife (Ms Chivers). On 19 July 2007 Ms Chivers entered into a contract to buy the boat for $385,219.35. Throughout July and August of 2007 Harburn Group paid the purchase price to the vendors of the boat via four installments, with Ms Chivers becoming the sole registered owner of the boat on 5 August 2007.

In 2008 Mr Harburn moved to another company and sublet Harburn Group’s premises. Harburn Group subsequently went into liquidation in 2011.

The liquidators brought an action against Mr Harburn and Ms Chivers for unreasonable director-related transactions, trying to get the Court to declare the transaction voidable and direct the money be paid back to the company. They also alleged that Mr Harburn breached his duties as a director under sections 181 and 182 of the Corporations Act 2001 (Cth) (Act).

At trial these claims were unsuccessful, with a finding that Mr Harburn had not acted unreasonably.

However, on appeal the Court found differently.

COURT FINDING: UNREASONABLE DIRECTOR-RELATED TRANSACTION

The liquidators submitted evidence regarding the company’s income and liabilities which led to the court accepting that at the time the boat payments were made Harburn Group was in uncertain financial and commercial circumstances in which questions as to its continuing solvency could arise in the short to medium term.

Section 588FDA of the Act was considered, as this section outlines when a transaction is an unreasonable director-related transaction. The factors in favour of the boat purchase being an unreasonable director-related transaction were:

The transaction was a payment made by the company (s 588FDA(1)(a));

The payment was made to a close associate of a director of the company (s 588FDA(1)(b)), as under s 9 a ‘close associate’ includes a ‘relative’ which includes a ‘spouse’; and

A reasonable person in the company’s circumstances would not have entered into the transaction (s 588FDA(1)(c)).

In regards to the final point the Court outlined that the ‘company’s circumstances’ encompass all relevant matters including its status as a company; its controllers, shareholders, business and other activities; and the circumstances of the transaction itself.

The court considered under s 588FDA(1)(c) that:

There were no benefits to the company in making any of the payments;

However, there was detriment to the company by way of the full extent of the payments; and

Mr Harburn’s wife benefited from the transaction.

This led to the Court’s conclusion that a reasonable person in the company’s circumstances would not have made the payments, regardless of the financial health of the company.

Mr Harburn tried to allege that the money used to purchase the boat was actually a dividend to him. This argument was rejected by the Court as there was no contemporaneous evidence to support that such a dividend was proposed to be paid.

Mr Harburn also claimed that because of the financial position of the company there was no obligation to have regard to the best interest of creditors and thus the best interests of the company were equivalent to his own interests. This was also rejected, with the Court noting that there was no evidence that the sole shareholder had consented to the payment and consent of the shareholder could not be implied from the director’s knowledge and involvement in the transactions.

The Court stated, “The commercial and financial advantages of conducting a business through companies...have the consequence that those responsible for the administration of the company are prevented from using the corporate…property as if it was their own.”[1]

COURT FINDING: BREACH OF DIRECTOR’S DUTIES

The Court also considered whether Mr Harburn had breached:

Section 181(1) of the Act, which requires a director to exercise their powers and discharge their duties (a) in good faith in the best interests of the corporation and (b) for a proper purpose; and

Section 182(1) of the Act, which provides that a director must not improperly use their position (a) to gain an advantage for themselves or someone else or (b) to cause detriment to the corporation.

The Court observed that the boat payments constituted a gift of a very significant magnitude for which there was no arguable commercial justification. Additionally, the sole shareholder of the company had not appeared to have consented to the payments.

The Court concluded that Mr Harburn had not exercised his powers or discharged his duties for a proper purpose, putting him in breach of s 181(1)(b). He was also in breach of s 181(1)(a) as he knew at the time of the boat payments that the company was in uncertain financial and commercial circumstances, so by making those payments he was not acting in good faith in the best interests of the company.

Further, Mr Harburn had used his position to gain an advantage for his wife at the obvious detriment of the company, so he was also found to be in breach of s 182.

OUTCOME

The Court ordered Ms Chivers to pay the sum of $385,219.35 as well as interest, pursuant to s 588FF (this related to the unreasonable director-related transaction claim) from the date the demand was made by the liquidators until judgment.

Mr Harburn was also ordered to pay compensation to the company in the sum of $385,219.35 plus interest pursuant to s 1317H (this related to the breach of director’s duties) from the date the payments were made until judgment.

This case demonstrates that company funds should not be used for personal reasons, including purchasing something for yourself or someone close to you where no benefit is discernible for the company.

As the case demonstrates, using company funds in such a manner is a breach of a director’s duties under the Act, regardless of the financial status of the company and can result in both repayment of the amount paid and compensation also being required to be paid.

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